When Merrill Lynch & Co. announces fourth-quarter results this week, one of the first things that investors will check is whether the firm finally has corrected problems in its $5.5 billion small business loan portfolio.

The business financial services unit had unexpectedly large loan loss provisions last year, which reduced Merrill's reported net income at a time when other banks increased their earnings by releasing loan reserves.

The financial services giant says the situation is much improved after a series of management changes and tougher monitoring of the loans that it makes.

New policies

"We have put enhanced policies and procedures in place to review the quality of our loan portfolio on an ongoing basis," says a senior Merrill spokesman. "The review has been completed and the business is in great shape."

This month, the company named 33-year banking industry veteran Scott Kisting as the new head of business financial services. He took over for David Tralka, who was quietly placed on leave late last year, and then resigned. Mr. Kisting will work to expand consumer banking as co-head of Merrill's global private-client group.

Mr. Kisting has the experience to enforce discipline in the lending business. He has served as national director of the Risk Management Association. From 1990 to 1997, he also was group executive vice president at Norwest Corp. Subsequently, Mr. Kisting worked as president of retail and commercial banking at California Federal Bank.

Merrill also altered reporting relationships in its senior management ranks to give more attention to small business. In addition, the company rejiggered policy and personnel at its Chicago-based BFS underwriting office to make sure the company gets timely information on credit quality.

Some observers are skeptical about the company's quick fixes. They complain that Merrill has not been forthcoming about the unit's problems, which came to light in the third quarter of last year.

Investor concern

"It remains to be seen if the problems are behind them in this particular business unit," says Robert Hansen, an equity analyst at Standard & Poor's. "This will be an area of interest for investors."

BFS is a small but strategically important business. The unit makes loans of up to $5 million for small businesses, like contractors, that also have Merrill brokerage accounts. While the unit has been around for 20 years, Merrill officials have aggressively tried to expand it and other banking services in the last five years in order to diversify away from more cyclical Wall Street business lines.

Growing pains became evident in 2004. At first, Merrill officials were reluctant to acknowledge the problem. But after increasing reserves for small and middle-market loans by $140 million in the first nine months, and being evasive about its reasons for doing so, Merrill finally admitted in regulatory filings that it couldn't collect on a larger-than-expected amount of problem loans.

A number of competitors in the New York City market say that setting interest rates too low led to some of the problems. Merrill's BFS unit competes mainly with banks that cater to small business, including Commerce, North Fork, Citibank and J.P. Morgan Chase Bank.

When questioned about the increased loan loss reserves during the third-quarter conference call with analysts, Merrill executives first claimed that the move was a response to a larger loan portfolio that grew about 10% in one year-more loans, more reserves, in effect.

Later, when the company filed its quarterly report with the Securities and Exchange Commission, it acknowledged that the increase in reserves resulted from declining credit quality during the quarter, adding that--without supplying detailed numbers--the troubled loans constituted only a small portion of the $5.5 billion portfolio.